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Understanding agent-based models of financial markets: a bottom-up approach based on order parameters and phase diagrams

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  • Ribin Lye
  • James Peng Lung Tan
  • Siew Ann Cheong

Abstract

We describe a bottom-up framework, based on the identification of appropriate order parameters and determination of phase diagrams, for understanding progressively refined agent-based models and simulations of financial markets. We illustrate this framework by starting with a deterministic toy model, whereby $N$ independent traders buy and sell $M$ stocks through an order book that acts as a clearing house. The price of a stock increases whenever it is bought and decreases whenever it is sold. Price changes are updated by the order book before the next transaction takes place. In this deterministic model, all traders based their buy decisions on a call utility function, and all their sell decisions on a put utility function. We then make the agent-based model more realistic, by either having a fraction $f_b$ of traders buy a random stock on offer, or a fraction $f_s$ of traders sell a random stock in their portfolio. Based on our simulations, we find that it is possible to identify useful order parameters from the steady-state price distributions of all three models. Using these order parameters as a guide, we find three phases: (i) the dead market; (ii) the boom market; and (iii) the jammed market in the the phase diagram of the deterministic model. Comparing the phase diagrams of the stochastic models against that of the deterministic model, we realize that the primary effect of stochasticity is to eliminate the dead market phase.

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  • Ribin Lye & James Peng Lung Tan & Siew Ann Cheong, 2012. "Understanding agent-based models of financial markets: a bottom-up approach based on order parameters and phase diagrams," Papers 1202.0606, arXiv.org.
  • Handle: RePEc:arx:papers:1202.0606
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    References listed on IDEAS

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    6. Lux, T. & M. Marchesi, "undated". "Scaling and Criticality in a Stochastic Multi-Agent Model of a Financial Market," Discussion Paper Serie B 438, University of Bonn, Germany, revised Jul 1998.
    7. Raberto, Marco & Cincotti, Silvano & Focardi, Sergio M. & Marchesi, Michele, 2001. "Agent-based simulation of a financial market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 299(1), pages 319-327.
    8. Levy, Haim & Levy, Moshe & Solomon, Sorin, 2000. "Microscopic Simulation of Financial Markets," Elsevier Monographs, Elsevier, edition 1, number 9780124458901.
    9. Sato, Aki-Hiro & Takayasu, Hideki, 1998. "Dynamic numerical models of stock market price: from microscopic determinism to macroscopic randomness," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 250(1), pages 231-252.
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    Cited by:

    1. Gualdi, Stanislao & Tarzia, Marco & Zamponi, Francesco & Bouchaud, Jean-Philippe, 2015. "Tipping points in macroeconomic agent-based models," Journal of Economic Dynamics and Control, Elsevier, vol. 50(C), pages 29-61.
    2. Kononovicius, A. & Gontis, V., 2014. "Control of the socio-economic systems using herding interactions," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 405(C), pages 80-84.

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